'Disaster Bonds' Miss Their Mark

By

Jeannette Neumann

Jan. 24, 2013 7:01 p.m. ET

In December, an Iowa state agency issued $1.2 billion in municipal bonds for an Egyptian company to build a fertilizer factory. The bonds qualified for tax-exempt status under a U.S. program to aid Midwestern states flooded in 2008.

The "disaster bonds" got another boost from a loophole that was perfectly legal: In 2010, state officials ruled, based on guidance from the Internal Revenue Service, that companies could use such bonds even if they weren't hurt by the devastating floods or located in the hardest-hit parts of Iowa.

State officials said the wiggle room was needed to get the most impact from disaster bonds. Since 2002, Congress has authorized local and state agencies to borrow as much as $37.5 billion in the municipal-bond market on behalf of private companies to spur recovery efforts after the Sept. 11, 2001, terrorist attacks, Hurricane Katrina and the 2008 floods. State agencies issue the disaster bonds, but the private companies are responsible for paying back the debt.

"We didn't want to leave this federal resource untapped," said
Lori Beary,
the Iowa Finance Authority's community-development director. Iowa softened its disaster-bond requirements as initial demand was lackluster because many companies were wary of sinking into debt.

But others have said such flexibility means disaster-bond programs haven't always helped communities that were battered the most. "The funds need to be targeted geographically to help the neediest places," said
Robert Puentes,
a Brookings Institution senior fellow.

The disagreement is likely to intensify now that officials in the Northeast are pressing lawmakers to allow cities and towns in New York, New Jersey and Connecticut to sell as much as $20 billion in disaster bonds to jump-start rebuilding following superstorm Sandy last October.

Last week, the House approved a $50.5 billion recovery-aid package, and the Senate was expected to take up the measure as soon as Thursday evening. That would clear the way for debate over a broader tax-incentive package that likely would include Sandy-related disaster bonds. Reps. Bill Pascrell (D., N.J.) and Charles Rangel (D., N.Y.) support Sandy bonds, though it was a slog to get previous Sandy aid bills through Congress.

ENLARGE

A review by The Wall Street Journal of tax-exempt bonds issued after earlier disasters shows that companies often weren't required to prove they needed the bond-sale proceeds to help them recover. Little of the money was spent in communities that bore the brunt of the calamity. For example, Butler County was Iowa's third-worst-hit county in 2008, but no bond dollars were spent within its borders.

Congress approved the most recent disaster-bond program, which would likely serve as a blueprint for Sandy bonds, after the floods that devastated the Midwest in 2008.

Iowa was among the biggest issuers of "Midwestern Disaster Area Bonds." Its counties and state authorities sold $2.6 billion of the securities from 2009 through December 2012. The state was ravaged in the summer of 2008 by torrential rains that flooded nine rivers in the state, forcing tens of thousands of residents to flee their homes and destroying billions of dollars of property.

Seventy-eight of Iowa's 99 counties qualified to tap the program. Lee County ranked 20th in terms of worst-hit Iowa counties, according to an analysis of Federal Emergency Management Agency data, and received $9.3 million in federal aid, or 0.7% of the total funds. But the county, home to about 35,600 residents, ranked first in bond dollars spent on projects within its borders, with 46% of the total. That is thanks to $1.2 billion of bonds sold by a state authority on Dec. 19 on behalf of the Iowa Fertilizer Co. The firm is owned by Cairo-based
Orascom Construction Industries
SA
E, which is one of the world's largest fertilizer makers.

When the state agency, the Iowa Finance Authority, first began issuing Midwestern Disaster Areas Bonds for firms in 2009, a company had to prove it suffered a loss in business or damage because of the floods, or was replacing a business that was hurt. Projects in the counties that were hardest hit by the flood were given priority. In 2010, the authority loosened those requirements following guidance from the IRS that a state's governor could determine whether a proposed project was replacing a damaged business.

Indiana took a similar approach. A project was awarded bond funding as long as it was within a county that had been declared a disaster area in 2008.

"There have been $2.1 billion of investments made in the state of Indiana over the last three years, and a very large portion of that would likely not have been made" without disaster bonds, said
Jim McGoff,
general counsel of the Indiana Finance Authority.

Midwest Fertilizer Corp. officials estimate they shaved off up to two percentage points, to about 5% from about 7%, borrowing through the disaster-bond program compared with typical commercial financing.

Ausaf Qureshi, the company's secretary, said in an email that the ability to raise $1.3 billion from the municipal-bond market "played a major role in our decision to go with Indiana." The plant is set to be finished in 2016, Mr. Qureshi said. Midwest Fertilizer is a unit of the Fatima Fertilizer Co. and Fazal Cloth Mills Ltd., described in bond documents as "part of one of the largest conglomerates in Pakistan."

The plant is being built in Posey County, which ranked 33rd in terms of worst-hit Indiana counties but was first in bond dollars spent on projects within the state, with 58% of the total.

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